This article is composed from a series of tweets that I published yesterday afternoon. But this trust can be quickly undermined if the authority over how much money is "printed" ("supplied") transfers from the Federal Reserve to the Treasury; and the rationale for how much money is "printed" is no longer the maintenance of a stable currency, but the Treasury's deficit-financing needs. But, it has been going on for some time now -- long enough to tempt the MMT fans to indulge in their money-for-nothing fantasies. These Are the Biggest Weaknesses of Modern Monetary Theory 1. You could say that these countries were the canaries in the coal mine for Western economies. This really is modern; but I haven't seen any "MMT" theorist who can explain it. This is a mistake and we have historical evidence to prove that America's ability to run chronic budget deficits is not constrained only by inflation, but also by the willingness of foreigners to hold our dollars in reserve. Progressive politicians have seized on modern monetary theory (MMT) to justify their free-spending policies. 1. But when a government declares, via various silly justifications, that it intends to use the printing press to finance itself, it typically finds that it cannot without a currency breakdown. (See here and here for Modern Monetary Theory’s critique of the Left’s redistributive approach to monetary politics.) Equating dollars with capital assigns a false sense of power to the government and seems to suggests that without a central authority able to issue currency by fiat that the private sector would be unable to generate "surpluses." Since the answer might be "zero"--and in recent months it has actually been negative: the Federal Reserve has been reducing its government bond holdings, in effect "unprinting" the money--the Treasury has to act as if it did not have this advantage. What Modern Monetary Theory gets ‘plain wrong,’ according to former IMF chief economist Published: June 11, 2019 at 4:02 p.m. One of the central arguments of MMT's proponents is that government deficits create private sector surpluses. So long as people accept the basic moral (yes moral, not economic) principle of a thing, then the policy which most consistently embodies that principle tends to win. It was not until the Volcker administration moved from interest rate targeting, to outright targeting of monetary aggregates (i.e. dollars). Historically, beginning with the Bank of England in 1694, central banks were private, for-profit institutions. Modern Portfolio Theory (MPT) had one major flaw from the beginning. The Federal Reserve decides. Because we trust the Federal Reserve not to make too many mistakes (rightly or wrongly), we are thus willing to hold ("demand") a large amount of dollars. This is actually a return to old-fashioned banking principles, after a long time in the 1970-2008 period when banks attempted to maximize profitability by holding as little idle cash as possible. Much of which is actually right in its basic ideas, it’s the application to the real world that doesn’t work. Printing money, as you might imagine, turned out to be very profitable. The following provides a brief critique of a relatively new monetary theory called Modern Monetary Theory also known as MMT. ET If you issue a bond, and never pay either interest or principal (the bonds are typically rolled into new bonds upon maturity), then it is as if you made them disappear. While open to some of its ideas, he, like many other mainstream economists, argues it has fundamental flaws. In effect, the interest rate on these bonds is zero. What are the major flaws you see within Modern Monetary Theory? The Federal Reserve remains a privately-owned entity, but it officially remits its income to the Treasury. In a response to Doug Henwood’s critique, Pavlina Tcherneva makes the case for the analytical power and political potency of of Modern Monetary Theory. To be blunt, MMT is fatally flawed, and someone needs to address those flaws head on. Keynes is more consistent than Friedman, and Kelton is more consistent than Keynes. So we see that "printing press finance" has been going on for a long time, and at a relatively large scale. After the Bretton Woods system ended in 1971, most of the industrialized nations’ currencies went from being fixed or “pegged” to gold to the “floating” currency regime that exists today. I often wonder if this is really true. MMT argues that “slack,” the... 2. Because we "demand" this, the Federal Reserve can thus "supply" a large amount of dollars, and the dollar does not lose value. By the end of the nineteenth century, this model had spread over much of the world. I highlight "five fatal flaws" - each of which, alone would debunk the theory - that I believe make MMT not only unworkable, but actually a step in the wrong direction. The modern monetary theory line (in one sentence, and also in video form) is that government debt levels are nothing to worry about, because governments are the issuer of the currency, and can always print more. Modern Monetary Theory is just the most consistent version. It is the same flaw that exists for most portfolios today. Federal Reserve Chairman Jerome Powell on Wednesday defended the current regime for managing inflation by talking down an alternative proposal for steering the economy: Modern Monetary Theory, or MMT. I write about economic topics in the Classical or "supply side" tradition. In fact, Krugman has actively criticized the MMTers himself (to which they responded here and here, to list just two instances). Each time was inflationary -- the Civil War, World War I and World War II. (In other words, supply was unchanged.) the money supply) that inflation came back under control in the 1980s. This is sometimes called a failure of "confidence" or "faith"; somewhat confusing terms to describe a change in the rational expectations of future behavior. What exactly is so "modern" about this I don't know. (In 2017 it was $80 billion, more than any other private company.) (That is the conclusion of yours truly after investigating in recent months.) MMT's advocates seem to take this status for granted. That money in your wallet has to come from somewhere. Opinions expressed by Forbes Contributors are their own. With more money in the system and no increase in demand for it, interest rates will tend to fall, not rise, MMT says. In recent years, a radical and unorthodox school of thought called “Modern Monetary Theory” (MMT) has become popular with some progressive economists, as well as with policymakers and activists on the political left. Other economists note Modern Monetary Theory is a decades-old idea that's been debated, and discarded, by mainstream economists. This evokes the words of Alan Greenspan: The United States can pay any debt it has because we can always print money … I write about monetary and tax policy for the 21st century. Actually, it is the money that economic participants "demand." It's hard to overestimate the impact that the dollar's role as a global reserve currency and medium of exchange has on its foreign exchange value (i.e. Modern Monetary Theory or Modern Money Theory (MMT) is a heterodox macroeconomic theory that describes currency as a public monopoly and unemployment as evidence that a currency monopolist is overly restricting the supply of the financial assets needed to pay taxes and satisfy savings desires. The theory is called Modern Monetary Theory (MMT). You may opt-out by. It is a recipe for disaster; but, even so, every government does it today, to some extent. Is there unemployment in species without money? It is as if the Treasury paid nothing at all. Â© 2020 Forbes Media LLC. "Demand" tends to grow with a growing economy, so "supply" will also grow alongside--in other words, money is "printed," with the government the eventual beneficiary. EY & Citi On The Importance Of Resilience And Innovation, Impact 50: Investors Seeking Profit â And Pushing For Change, Michigan Economic Development Corporation with Forbes Insights. What happened is that the dollar fell in value, without any money actually being printed (money supply was unchanged) because who would want to hold a currency that was going to be devalued? This in turn has been accomplished by forcing government bond yields to zero; a level at which a bank would rather hold BOJ deposits than government bonds. She said Modern Monetary Theory should be "a larger part of the conversation," in an interview with INSIDER in 2019.) They argue that monetary policy should play a supporting role, holding down interest rates to reduce the cost of public … Inflation was low throughout the 1990s and early 2000s at the same time as our financial system was becoming increasingly unstable. But, in time people complained about this arrangement. The irony of it is: that a government can, in part, pay its bills with the printing press, but this works best when the government acts as if it cannot; for once a government goes too far down this road, the government soon finds that confidence in the currency or the government's bonds has fallen so far that it can no longer use printing-press finance without disastrous and immediate consequences. When a government keeps its affairs in order, and acts as if it does not need to rely on money-printing to get by, it actually gets a small advantage from the money-creation process. If "supply" matches "demand," then the value of the currency will maintain stability. The only reason for the Treasury (per MMT) to use the printing press expressly for financing is because it needs to or wants to; and because it needs to or wants to, it will ignore inflationary concerns, even if it says that it will not, because that is the only reason to embark on this change in the first place. In other words, foreign exchange markets decide what the dollar is worth, not policymakers in Washington D.C. Low/stable inflation does not equal financial stability. An irrationally exuberant social mood, baby boomers in their prime income earning years (encouraged to buy stocks off widely adopted theories of "optimal portfolio construction"), financial deregulation, and booming productivity, led to an explosive growth in asset prices. Since the Federal Reserve doesn't seem to want to be audited, I guess we will just have to take their word for it. For instance, lets use an example that MMT advocates sometimes refer to groups of wild animals. In other words, the government has managed to finance itself "with the printing press" to the amount of about 100% of GDP, with no inflationary consequences. The assumption that there is such a thing as a “risk-free” asset. (A) I like to say that MMT is a mix of “old” and “new” ideas. This is functionally similar to if the Treasury simply ordered up $2.2 trillion in the form of $100 bills on forklift pallets, and used them pay bills. The Treasury never gets to say: "we want to fund this program so print us some money," even though effectively the money is often printed and the program funded. The funny thing is, if the Treasury did take over the money-printing role expressly for financing purposes, the value of the dollar would probably fall and "inflation" would erupt, even if the Treasury didn't print any money at all! Other factors can affect demand: since 2008, banks have apparently wished to hold much more of their assets in the form of "bank reserves," which basically means a cash account at the Federal Reserve. All Rights Reserved, This is a BETA experience. An economic framework that demands a zero rate of return on capital is anathema to the basic requirements of market capitalism. MMT builds on functional finance's removal of debt constraints on government borrowing. In the third century, the Roman government started paying its bills by making coins with higher and higher denominations. That reserve status is contingent upon having a credible monetary policy. … financial system was becoming increasingly unstable, outright targeting of monetary aggregates, The Future of the International Monetary…, On the Road Towards Decentralization: Part…, What's in a Message? It is an empirical fact that interest rate policy is insufficient to control inflation, as has been demonstrated by the failure of the Arthur Burns Federal Reserve to quell the stagflation of 1970's by simply "raising rates." In short: it is best if you act as if you can't, even when you can. To be blunt, MMT is fatally flawed, and someone needs to address those flaws head on. The Treasury pays the Fed, and the Fed gives the money back to the Treasury. During the twentieth century, central banks spread still further, but they officially took on a more public aspect, in which the interest income on their holdings of government bonds were remitted to governments. Its claims directly contradict thousands of years of human experience and are empirically invalidated by the last fifty years of monetary and financial history.